The friendlier attitude some individual investors have been displaying toward the stock market recently--after decades of disaffection--can hardly be described as a budding romance just yet. But "it may foreshadow a trend with important implications for both equities and the economy in the decade ahead," says economist William C. Melton of ids Financial Services Inc.
Although households were net direct sellers of stock, at a $28 billion annual rate, in the first half of this year, that's down sharply from last yearUs pace and the average $100 billion-plus annual liquidation rate that prevailed from 1984 through 1989. Moreover, net purchases of equity mutual funds through August already total $27.6 billion.
The upshot, says Melton, "is that households appear to be on the way to achieving significant positive net purchases of equity--directly and through mutual fund investments--for the first time in three decades."
Observers have attributed the slow liquidation of equity holdings by individuals that began in the late 1950s to such developments as the growth of the private pension system, which reduced the need for personal retirement savings and fostered the institutionalization of the stock market by pension funds and other financial intermediaries. But Melton blames the huge disgorgement of stocks by individuals in the 1980s on the takeover boom, which shrank the supply of equities by some $600 billion and thus "inevitably shrank the holdings of households as well." And investment strategist E. Michael Metz at Oppenheimer & Co. stresses Americans living beyond their means in the 1980s, as well as "the lure of extraordinarily high short-term interest rates."
Whatever the cause of the equity sell-off by households, however, the big question is whether the apparent revival of interest in stocks will grow. Melton thinks it will. Yields on fixed-income securities have declined markedly in recent years, he notes. And most of the purportedly "safer" investment vehicles that compete with stocks--from bank deposits and insurance policies to high-yield bonds, commercial real estate, and even homeownership--are now perceived to be far riskier than in the past. "In a world of risky investments, stocks, which consistently racked up double-digit returns during the past decade, look better and better," says Melton.
Metz notes that individual investors are entering the 1990s "with extraordinarily low exposure to equities as a percent of their financial assets." If interest rates and inflation move lower and stay there, as many economists predict, he believes households could become the dominant
purchasers of stocks in a market in which public and private pension funds with constrained cashflows are likely to take more of a backseat.
What might such a stock market be like? Metz sees less obsession with short-term performance and less use of indexes and other market derivatives. As individual investors reenter the market, volatility caused by herdlike behavior could decline, and emphasis on active stock selection is likely to grow. In such an environment, says Metz, "it is just possible that stock markets in the 1990s will better perform their classic functions of raising new equity and efficiently allocating capital."